Income inequality is up and tax rates are down

by pdxblake

Following up on Evan’s post this morning about the NY Times article which found that high-income Americans have seen their taxes fall dramatically compared with what they would have paid 30 years ago.  The reason the wealthy feel overtaxed is not because their taxes have gone up–they have gone down–but because their income has grown so much more so that they are paying higher levels, but far less than they would have paid thirty years ago.

One of the roles of government through a safety net is to keep inequality in check, by providing assistance to the people at the lower end of the income spectrum and by taxing lower incomes at lower rates than higher incomes (a progressive tax code).  The effect of the tax code is supposed to narrow the level of inequality in the economy because high inequality makes income mobility harder, and generally makes the country more like a developing country.

The Congressional Budget Office made a chart in a report in late 2011 showing the income share by income quintile (each quintile represents 20% of the population, arranged from lowest income to highest):

What this chart shows is that the (after taxes and income transfers from the government, i.e. Social Security, Unemployment Benefits) lowest four quintiles (the lower 80% of households) saw their share of total income decline from 1979 and 2007, while the 81st – 99th percentiles saw their share stay mostly flat.  The only area of growth in income share was among the 1 percent.

And, the change in income share is not due to rapid growth of income (except among the higher incomes):

In the chart above, the period is longer than the period that the CBO report covers, but you can pretty clearly identify where the growth of inequality started to really grow rapidly, around 1980, coincidentally enough.  Putting all this together with the analysis from the NY Times and it is hard to argue that the top 20%–and especially the top 1%–need more tax cuts (to keep the “job creators” happy of course), since they (through their political surrogates mostly, though not exclusively, in the Republican Party) are capturing both higher pre-tax incomes, but also lowering the tax rates they would pay on the same income level in 1980.

If you want to wade further into the weeds of tax policy, you can read this post by Kevin Drum (via Mark Thoma) about how the 1986 tax “reform” that hiked the payroll tax rate and allowed income tax rate cuts effectively allowed people who pay income taxes (the 53%) to “borrow” from payroll tax payers (who tend to be lower income on average, since payroll taxes are only paid on the first $106,800 of income).  Now that it is closer to the time when the trust fund runs out and the gap between current benefits and current payroll tax has to be paid out of federal income tax revenue, which will necessitate raising income taxes, to effective ‘repay’ the loan from payroll taxes over the last 25 years.